While note investing is by far my favorite form of real estate investing, the note investment world is not something you just jump into without understanding some of the basics I have previously outlined. This week I want to tap into some of the pitfalls you might find in the note investing world. I am only able to share these pitfalls based on the experiences I’ve had. I hope to pass along some of the wisdom I’ve gained and help you in your note investing career.
The Top 5 Pitfalls of Note Investing:
1) Buying Without Full Documentation:
If you purchase a note without all the right documentation you are taking a huge risk that the note is exactly what the seller has promised. Items like appraisals, homeowner’s credit report, job history and comparable sales are but a few items that you must get, review and agree with prior to your note purchase. Buying without this information is like skydiving without a parachute.
2) Buying a Note without the Underlying Asset:
It should go without saying that when you buy a real estate note, you are essentially buying the property with a promissory note. When that note is paid in full you relinquish your rights to the property. All too often the note buyer is given the note without the property. This leaves you, the buyer, scrambling to create security in your investment if the deal goes sour.
3) Failing to Escrow for Taxes and Insurance:
I admit it, at one time in my career advocated letting the homeowners pay their own taxes and insurance on the honor system. The end result was delinquent taxes, properties without insurance for a period of time, and basically a big mess. I had to work tirelessly to correct the issue. It took a lot of extra time to correct and the problem could have been avoided if taxes and insurance were put in escrow up front.
4) Buying a Disguised Non-Performing Note:
This falls into item #1, but there is a component that bares additional explanation. When you purchase a “performing” note, you know the homeowner has made their monthly payments, yet if you don’t get the last six months payment history there is no way to verify this fact. Investors can buy what they believe is a performing note at a great price only to find out it’s a non-performing note they overpaid for.
5) You Have to Forfeit on the Homeowner:
While this is more of a painful process than a pitfall you have to walk into note investing knowing you may have to forfeit on the homeowner if they fall behind in their payments. The forfeiture process varies in each state. While the silver lining is that you get the property back and get to retain all of the payments, you don’t have cash flow for several months, you take on attorney fees, and may have to do extensive repairs. You may also have to put insurance on the property and pay taxes. Again, all expenses you need to be aware of.
My goal in sharing these pitfalls is to help you avoid some of the mistakes and less than pleasant experiences I have had in note investing. All investments carry with them some level of risk, and because note investing can be such a highly rewarding investment, you also must be on the lookout for the pitfalls.
Have you experienced a note investing pitfall? Share your story here so we all can be successful.
Photo Courtesy: Tim Schapker